SELF STUDY QUESTIONS

1. Let the risk-free rate by 5%, and the expected market return is 14%. Consider two
securities, one with a beta coefficient of 0.5 and other with the beta coefficient of 1.5 with
respect to the market index.

[Link] the expected return for Security A as per the security market line

2. Compute the Expected return for Security B:

3. Provide the interpretation based on the computed Expected rate of returns.

2. Suppose the market premium is 9%, market volatility is 30% and the risk-free rate is 3%.

(1) What is the equation of the SML?

(2)Suppose a security has a beta of 0.6. According to the CAPM, what is its expected return?

(3)A security has a volatility of 60% and a correlation with the market portfolio of 25%. What is
the (Er)?

(4) According to the CAPM, what is its expected return?

(5) A security has a volatility of 80% and a correlation with the market portfolio of -25%.
According to the CAPM, what is its expected return?

3. (1) Evaluate Capital Asset Pricing Model, its major assumptions, and shortfalls in its use to
cost as well as pricing of an asset. Explain the shortfalls of CAPM

(a) Describe how Risk-Free Asset may influence portfolio expected risk and return prospective.

(b) Explain the Characteristics of the Market Portfolio.

4. An investor in the U.S. takes US$10,000,000 on January 1, 2024 and invests in shares

traded on the Tokyo Exchange (TSE). On January 1, 2024 the spot rate was , so
the investor received ¥1,300,000,000 and used this to acquire 65,000 shares at ¥20,000 each.

On January 1, 2025 the investor sold the shares at a price of ¥25,000 per share yielding

¥1,625,000,000 and converted the shares back to US$ at the new spot rate
which resulted in $13,000,000.
Calculate the return on a cross-border investment both the change in the share price and the
change in the currency value affect the total return of the portfolio.

5. As the Head of Investments for your company you are expected to compute the 10%
Value-at-Risk for your company’s portfolio containing two categories of assets. The first
category includes stocks which are traded on the Ghana Stock Exchange (GSE) with an expected
return of 15% and Standard Deviation (SD) of 12% per annum. The second category contains
GoG Bonds with an expected return of 16% and Standard Deviation (SD) of 5% per annum. The
annual correlation between the two categories of assets is 80% or .8. The total portfolio value is
US$50 million. The total investment in the Ghana stock exchange is US$30 million and US$20
million invested in Bonds.

(a) Compute the Portfolio Expected Rate of Rate

(b) Standard Deviation

(c) the Value-at-Risk

(d) Provide the worst case and highly unlikely interpretations for the Value-at-Risk.

(e) What will be the expected shortfall if the actual loss is US$1,000,000

6. As an analyst you are asked to consider the following bond for possible inclusion in your
company's fixed income portfolio assume the face value is US$1000:

Issuer Coupon Yield-to-maturity Maturity Duration

Wiser company 9% 9% 12 years 8.25 years

a. Explain why the Wiser bond's duration is less than its maturity.

b. Explain whether a bond's duration or its maturity is a better measure of the bond's sensitivity
to changes in interest rates.

Briefly explain the impact on the duration of the Wiser Company bond under each of the
following conditions:

c. The coupon is 4% rather than 9%.

d. The yield-to-maturity is 4% rather than 9%.

e. The maturity is seven years rather than 12 years

b. Compute the change in price as a result of 100 basis points change interest rate and
interpret the results.

7. You are thinking of buying IBM 6.25s20 bonds, priced at 92. The bonds pay

interest semi-annually. If your required rate of return is 8%, would you buy these bonds in

2011?

Bond price= PV of coupons + PV of par value

8. Napier Company has zero-coupon bonds maturing in 2018. The yield to maturity

for these bonds is 9%. Find the price of one of these bonds in 2001.

9. Checking the Wall Street Journal in 2001, you find that the Babbitt Co. 6s21 bonds

show the price as 68. The bonds pay interest semi-annually. If your required rate of return

for such bonds is 10%, would you buy Babbitt bonds?

10. The investors require 8% return on Keitel Corporation 5s2024 bonds that pay

interest semi-annually. Find the price of one of these bonds in 2011.

11. Ada Company 7% coupon bonds pay interest semi-annually. When you

bought one of these bonds, it had 11 years to maturity, and the appropriate discount rate

was 9%. After one year, the discount rate on such bonds is 8% because of the improved

financial health of the company. If you sell the bond today, what would be your capital

gain or loss?

12. Zeller Co bonds are selling at $602.50 each because the bondholders' required rate

of return is 15%. The bonds pay interest semi-annually and they will mature after 10

years. Find the coupon rate of these bonds.

and they will mature after 12 years. In the bond market, these bonds are selling at $900

each. If your required rate of return is 8%, would you buy one of these bonds?

14. Suppose you want to buy a PP&L bond with coupon 18.75% that matures in 5

years, and pays interest semi-annually. If the face value of this bond is $1,000, and your

required rate of return is 12%, how much should you pay for this bond?

3.23. IBM bonds have a coupon rate of 8%, pay interest semi-annually, and will mature in

8 years. What is the price of a $1,000 IBM bond if the investors have a required rate of

return of 7%?

15. You believe that there is a 30% probability that the dividend paid by IBM next year is
going to be $4.50, and a 70% probability that the dividend will increase to $5.00. You
also feel that IBM will grow at the rate of 8% for the long term. Your required rate of
return for IBM stock is 12%. How much should you pay for a share of IBM?

16. You bought a stock at $45 last year. After one year, you received a dividend of $2.50,
and then sold the stock for $49.00. Calculate the rate of return on your investment.

17. Jameson stock has just paid its annual dividend of $2.25. The expected growth rate of
James is 7% in the long run. If your required rate of return is 16%, how much should you
pay for a share of Jameson stock?

18. Treynor's Index (Ti) = (Ri - Rf)/Bi.

Where, Ri represents return on fund, Rf is risk free rate of return and Bi is beta of the
fund
Calculate the risk/reward Ratio (Treynor T) for each portfolio
1. T (M)=
2. T(D)=
3. T(E)=
4. T(F)=
5. Based on the above calculations, interpret your findings.

19. Calculate the standard deviation and the expected return of a portfolio with 40% invested
in the following US equity and 60% invested in the following German equity index.

Expected Return Expected Risk (σ)

United States equity index (US) 14% 15%

German equity index (GER) 18% 20%

Correlation coefficient (ρUS,GER) 0.34

a. Compute the Expected Return of Return

b. Compute the portfolio variance

c. Compute the portfolio standard deviation

d. Describe the diversification effect on the portfolio.

20. Suppose Portfolio P’s expected return is 15%, its volatility is 30% and the risk-free rate is
5%. Suppose further that a particular mix of asset i and P0 yields a portfolio P 1 with an
expected return of 25% and a volatility of 45%. Will adding asset i to portfolio P0 be
beneficial? Explain how